Introduction to Corporate Governance

Question 1

What is meant by the term ‘Corporate Governance’

Answer 1

‘The system by which companies are directed and controlled’ The Cadbury Committee 1992

‘a set of relationships between a company’s management, its board, its shareholders and other stakeholders…. Also provides the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance’ OECD 2004

Question 2

What are the 4 areas of conflict as set out by Jensen & Meckling?

Answer 2

• Moral Hazard
• Level of Effort
• Earnings retention
• Time horizon

Question 3

What are the 4 theoretical approaches to Corporate Governance?

Answer 3

• The Shareholder Value Approach
  – ‘The board of directors should govern their company in the best interest of its owners’
• The Stakeholder Approach (pluralist approach)
  – ‘achieving a balance between economic goals and social goals
• The Enlightened Shareholder Approach
  – Pursue the interests of shareholders in an enlightened and inclusive way
• An integrated Approach
  – ‘consideration of the interests of all stakeholders on the basis that this is in the best interest of the company.’

Question 4

What is stakeholder capitalism?

Answer 4

Stakeholder capitalism seeks to create shareholder returns by creating value for society as a whole, i.e. customers, employees, suppliers, communities, and the environment.

Question 5

What are the 4 principles of good corporate governance

Answer 5

• Responsibility
  – Those given authorities should accept full responsibility for the powers that they have been given and the authority they exercise. They should carry them out ethically with honesty, probity and integrity.
• Accountability
  – This refers to the requirement for a person or group of people in a position of responsibility to account for the exercise (or not) of the authority they have been given. They should provide ‘honest’ information and not manipulate facts.
• Transparency
  – This refers to the ease with which an outsider is able to make a meaningful analysis of an organisation and its actions.
• Fairness
  – This refers to the principle that all key stakeholders should be treated fairly when decisions are made or actions taken by the organisation.

Question 6

What are 5 benefits of a company having a good reputation?

Answer 6

• Improving relations with shareholders
• Creating a more favourable environment for investment and access to capital
• Recruiting and retaining the best employees
• Attracting the best business partners, suppliers and customers;
• Reducing the potential for crisis

Question 7

Explain the difference between ‘Comply or Explain’ and ‘Apply and explain’ and give examples of corporate governance codes using these approaches

Answer 7

• ‘Comply or explain’
  – Where the company believes that it is not in its best interests to ‘comply’ with a provision of the code, it is required to ‘explain’ to shareholders why they have not complied e.g. UKCG Code
• ‘Apply and explain’
  – Avoids ‘tick box’ mentality and focusses organization to apply principle and explain how. e.g. King IV, Wates

Question 8

List 5 benefits to adopting good Corporate Governance practices?

Answer 8

• Succession planning
• Lower cost of capital
• Improved share performance
• Long-term sustainability
• Improved access to external financing

Question 9

What are the potential consequences of weak governance practices, providing examples?

Answer 9

Corporate failure
– Accounting fraud
– Lack of knowledge skills and experience on the board, e.g. Barings Bank
– Dominant personalities, e.g. Maxwell
– Failure to understand and manage risk, e.g. global financial crisis, Carillion

• Reputational problems
  – Unethical business practices, e.g. Volkswagen ‘Dieselgate
  – Lack of transparency and disclosure, e.g. Olympus
  – Poor relationship between the board and shareholders, e.g. Sports Direct
  – Inappropriate remuneration and reward systems for directors and senior executive, e.g. Enron, Carillion

Question 10

What is the Corporate Governance Framework made up off - 5 examples

Answer 10

Applicable laws, regulations, standards and codes
Organisation’s constitution
Structures
Policies
Procedures

Question 11

Approaches to applying to Corporate Governance Framework

Answer 11

Applicable laws, regulations, standards and codes
Rules-based approach
Principles-based approach
Hybrid approach

Question 12

Two Theories of Corporate Governance

Answer 12

Shareholder primacy theory
“The business of business is business.”
Based on doctrine of Milton Friedman whose theory of business ethics states that “an entity’s greatest responsibility lies in the satisfaction of the shareholders.”

Stakeholder theory
Criticism of shareholder primacy since 2008 based on short termism, executive behaviour, risk

Question 13

Consequences of weak governance practices for industry

Answer 13

1. Excessive regulation – many of the laws, regulations, standards and codes introduced globally have been in response to the scandals that have resulted from weak governance practices
2. Lack of investment in capital markets – evidence shows that investors place importance on good governance practices when investing in companies. A lack of those practices can therefore lead to a lack of investment.
3. The development of shareholder representative bodies, such as the Investment Association or functions within some of the larger institutional shareholders specifically for monitoring the corporate governance practices of the companies they invest in, e.g. Hermes, CalPERS.
4. A focus on regulating and disclosing senior executive pay.
   The establishment of powerful regulators such as the US Securities and Exchange Commission.